Models hand out flyers and display signs encouraging the public to purchase health coverage under the Affordable Care Act during a promotional campaign launched by Colorado HealthOP, a health care co-op, in Denver on Oct. 1. (Brennan Linsley/AP)

When the new health-care law was being cobbled together, Congress decided to establish a network of nonprofit insurance companies aimed at bringing competition to the marketplace, long dominated by major insurers.

But these co-ops, started as a great hope for lowering insurance costs, are already in danger.

While the debut of the Affordable Care Act this month has been marred by widespread computer problems, the difficulties the co-ops face have been less obvious to consumers. One co-op, however, has closed, another is struggling, and at least nine more have been projected to have financial problems, according to internal government reviews and a federal audit.

Their failure would leave taxpayers potentially on the hook for nearly $1 billion in defaulted loans and rob the marketplace of the kind of competition they were supposed to create. And if they become insolvent, policyholders in at least half the states where the co-ops operate could be stuck with medical bills.

Although the co-op plan originated in the Senate, resistance to the initial proposal quickly materialized on Capitol Hill, in part because of pressure from insurance industry lobbyists.

So Congress saddled its new creations with onerous restrictions that, experts say, doomed many co-ops to failure. Federal grants for the co-ops were converted to loans with tight repayment schedules; they were barred from using federal money for crucial marketing; and they were severely limited from selling insurance to large employers, which represent the most lucrative market.

And even as the Obama administration was setting up the program, White House officials, who had no pride of authorship and feared it would be risky, repeatedly suggested that funding for the co-ops be reduced, according to more than half a dozen people familiar with budget negotiations and the legislative debate. The funding was cut to a small fraction of what experts told Congress would be needed for the ventures to be viable.

Brian Cook, a spokesman for the Centers for Medicare and Medicaid Services (CMS), the federal agency overseeing the co-ops, said it is closely monitoring their progress and is “confident that co-ops will be an important option available to millions of consumers.”

But while the program was meant to be nationwide, only two dozen co-ops have begun selling insurance on the new health-care exchanges. The difficulties the co-ops are confronting pose a challenge to the new law that is largely separate from the troubled rollout of the exchanges this month. But the problems, in particular the malfunctioning federal Web site, are hitting the co-ops hard because they depend on the exchanges for business.

The co-ops differ from traditional insurers in their nonprofit status, consumer focus and organizational structure; they will be governed by boards controlled by policyholders.

Those co-ops that have opened their doors are scrambling to prevail against the odds, sending their small staffs door to door to educate people about what they do without violating a ban on explicit marketing. To get around what she called the “really difficult” restriction, Julia Hutchins, chief executive of the Colorado Health Insurance Cooperative, was reduced to dispatching scantily clad models into the streets of Denver to urge people to “get covered.’’

The Obama administration has estimated that more than a third of the nearly $2 billion it has lent to co-ops will not be repaid.

The co-ops have been set up by health-care organizations, such as hospitals and doctors groups, as well as by local businesspeople, unions and community groups, and are being run by a variety of people, including former hospital and insurance executives and two former state insurance commissioners.

Despite the obstacles, co-op leaders say that the federal loans will help them succeed and that it is imperative that they do. “It is truly a historic moment . . . in the history of health care,’’ said John Morrison, president of the National Alliance of State Health Co-Ops, the co-ops’ trade group.

But Karen Davis, a professor of health policy management at the Johns Hopkins Bloomberg School of Public Health, said the co-ops were not designed with the support they need to thrive. “One provision after another got stuck in there to limit their probability of success,’’ she said. “It’s a little ironic to say you are for competition in the free market and then you don’t make it easy for new entrants.’’

Government money needed

It all started with “co-op night” in North Dakota. For two decades, leaders of the state’s numerous agricultural and other cooperatives had a chance at an annual forum to preach their virtues to one of Washington’s most powerful lawmakers, Sen. Kent Conrad (D-N.D).

When Senate leaders were seeking in 2009 to make the insurance market more competitive amid opposition to a proposed government-run health plan commonly called the public option, they turned to Conrad, who chaired the Budget Committee. He suggested co-ops. He said their potential to compete with major insurers while remaining out of government hands could place co-ops in a middle ground acceptable to Democrats and Republicans.

But the American history of health insurance co-ops has been “littered with failures,’’ Davis said. If these new entities were going to succeed, experts told Congress, they would need government help.

“The second we heard it, it raised red flags,’’ said one person involved in the congressional debate who spoke on the condition of anonymity to convey private conversations. “What kind of funding would it take to get this to a place where we could trust they wouldn’t default and leave people enrolled in co-ops all high and dry?’’

Congress commissioned insurance and actuarial experts to find out. They recommended $10 billion. Early legislative drafts funded the co-ops at that amount through government grants, because Conrad argued that loan repayments would excessively burden them.

The insurance industry balked. Industry lobbyists objected to what they called unfair government backing for the co-ops and raised concerns that they were not financially viable. Others familiar with the lobbying effort said the insurers didn’t want the competition.

If the government was to finance the co-ops, the lobbyists said, the new entities should get loans, not grants. “They were being given a gift, a federal handout,’’ said Philip Stalboerger, a former lobbyist for Blue Cross and Blue Shield of Minnesota.

The insurance industry had an ally in Sen. Ben Nelson (D-Neb.), and he had emerged in late 2009 as a key vote for the bill’s passage. He insisted to Senate Democratic leaders that co-ops receive loans instead of grants, and they consented. Nelson, a former insurance lawyer and insurance company chief executive, said he objected to the government giving money to an “insurance entity.”

In another provision sought by industry lobbyists, the legislation said “substantially all” of the co-ops’ business must be in the individual and small-group insurance markets, meaning the outfits were essentially barred from the lucrative large employer market.

The law allowed co-ops to band together to purchase actuarial and other services, but it prohibited them from jointly negotiating contracts with doctors, which could have helped them compete with major insurers. Although the law required the administration to give top consideration to co-op applicants with significant private financial funding, it hampered their means of getting it by preventing them from accessing equity markets or investor capital.

Then there was the restriction on using federal money for marketing.

The changes still rankle Conrad, who left the Senate in January. “The long knives were out for this,’’ he said in an interview. “No money could be used for marketing? Really? That was clearly intended to be a poison pill.’’

Funding cuts

By the time the bill passed, Congress had cut co-op funding from $10 billion to $6 billion. When the White House got involved, it was reduced even more.

Some senior White House officials considered the co-ops risky, including for prospective policyholders, and questioned whether the loans would be repaid, said multiple people familiar with their thinking.

As the administration prepared to implement the health-care law, there was also concern that the co-ops could leave the White House vulnerable to GOP criticism. Republicans began investigating the co-ops and pressing comparisons to Solyndra, a bankrupt California solar-panel maker that defaulted on a half-billion-dollar federal loan.

White House backing melted. The administration offered up the co-ops as a potential savings in April 2011 budget negotiations with Republicans, and their funding was cut by an additional $2.2 billion, according to people familiar with the negotiations.

Last year, as Washington approached what was being called the “fiscal cliff,” the White House again put co-op funding on the table. With hours remaining before the deadline, Senate Mi­nority Leader Mitch McConnell (R-Ky.) buttonholed Democrats in a Capitol hallway and said, “We want the co-op money,” according to a person familiar with the negotiations. The White House agreed.

Conrad was blindsided by the deal. “To do this in the dark of night and never even bother to tell me?’’ he said. “It was a very significant blow to the co-ops.’’

The last-minute cut eliminated the remaining co-op funding, leaving only a small contingency fund, and prevented the administration from lending additional money. Applications from more than 40 proposed co-ops were junked.

If the co-ops were set up in a way that made many likely to fail, the way their financing was designed meant taxpayers could pay the toll.

As a condition of licensing the co-ops, state insurance commissioners insisted that most of their federal loans be structured so that state officials can control whether and when the loans are repaid. If the co-ops run into trouble, state officials can order them to withhold payment. And if they go under, any remaining money will go to doctors and other debtors before the federal government, according to loan documents and insurance industry officials.

And despite the assurances of some co-op advocates, policyholders in some cases could be left with medical bills. “It’s always possible,” said Monica J. Lindeen, commissioner of securities and insurance in Montana. That’s because at least 11 of the co-ops, because of the way they’re licensed, are not eligible for the guarantees available to traditional insurance companies, industry officials said.

Obstacles remain

Officials at CMS did what they could to help. They designed regulations saying that co-ops could use federal funding to educate people about their companies, although they could not mention specific insurance plans. CMS also clarified that one-third of co-op policies could be in the large-employer market.

A study released by the co-op alliance found that average premiums in states with co-ops are about 9 percent less than in states without, although it is unclear what accounts for the difference. If co-ops do force prices down, that could save the government money by reducing subsidies for people buying insurance on the exchanges, supporters say.

Yet the obstacles remain daunting. “This is by far the most challenging thing I’ve been involved with in my 21-year career,’’ said Peter Beilenson, a former Baltimore health commissioner who is chief executive of Evergreen Health Co-Op in Maryland.

The Maryland outfit is one of at least three co-ops forecast to have financial problems in internal application reviews by Deloitte, a contractor for the Department of Health and Human Services. The review, uncovered by House Oversight and Government Reform Committee Chairman Darrell Issa (R-Calif.), said the Maryland co-op initially did not qualify for funding because its financial statements “indicate a tenuous ability to remain financially solvent.’’

The reviews also found that New York’s co-op had overly high debt and may have been overstating assets, while New Jersey’s co-op was projected to have expenses grow faster than revenue, “a negative indicator of the co-op’s ability to remain financially solvent.’’

Officials at all three co-ops said they are optimistic about their finances and ability to repay federal loans. They said high debt and expenses are typical of any start-up.

In July, an HHS inspector-general audit found that 11 co-ops had projected start-up expenditures that exceeded their start-up funding — and that there was “little evidence” of critical private support for 16 co-ops.

In Vermont, the state denied the co-op a license in a scathing report that said it would lose millions of dollars. HHS terminated the co-op’s $33.8 million in loans last month, forcing it to dissolve. Christine Oliver, the co-op’s former chief executive, said it will be unable to repay $4.5 million that had been spent.

In Ohio, co-op chief operating officer Briggs Hamor said the federal restrictions are posing “a ton of challenges.” His co-op, InHealth Mutual, missed the deadline to get licensed in time for the exchange this year.

“There really is a fighting chance for us,’’ Hamor said. He added, “I do think there will be some co-ops that will struggle for whatever reason and probably not make it.’’